BUSINESS VALUATION PART 3: COMPARABLE DATA
One of the principles of business valuation is the use of “comparables”. Since similar businesses will have similar risk profiles and investors would expect similar payback periods, similar earnings multiples should be used. So by comparing one company to other similar companies that have recently sold, we can gain a lot of insight into the appropriate valuation of the target company.
Comparing public companies is easy because they have to disclose their financials, but finding data on private companies is much more difficult. Some comparable data on large private companies is captured in private M&A databases such as Zephyr, Thomson Reuters and MergerMarket, but subscriptions to these databases are very expensive so they are inaccessible to most small businesses. In the UK the PERDa database captures the PE ratios of recently sold businesses, but it distils the entire market down to an average: just one number to represent every business that was sold in the quarter.
But the biggest problem with these sources is that they focus on much larger companies than our clients are interested in – for example, the average enterprise value of a company in the most recent PERDa analysis was £21.4m, with average pre-tax earnings of £3.6m. The other databases focus on deals most of which are in the $10m+ range. Given that size is the most important determinant of PE multiple, it simply isn’t helpful to compare data from these companies if we are interested in small businesses turning over less than £2m. In other words, the comparables are not very comparable.
SMALL BUSINESSES
So where can we find comparables that are actually useful? The starting point for most people is their own industry knowledge - normally they will be aware of recent sales of a few businesses in the industry. Sale prices of private businesses are usually not made public but occasionally this information can be gleaned through friends and associates, although rarely with any degree of confidence. The financials of the businesses are not public either, but people who know their industry well can usually gauge with some accuracy the relative sizes of their direct competitors. This basic knowledge of a few local sales, with scant details, is often the only comparable data we have.
Thankfully, more data is available. There are two good sources of extensive small business comparables, if you know where to look. Both of these datasets are from the United States, but they provide useful insights where otherwise there is very little available. While the data is not directly transferable to countries outside of the US, we can still draw very useful comparisons from it. Because the size of businesses captured is at the right level, this data is arguably far more useful than local data on businesses of the wrong size.
BIZBUYSELL INSIGHT REPORTS
The business for sale listing site BizBuySell.com publishes quarterly and annual Insight Reports, which are analyses of its quarterly surveys of business brokers. The second quarter reports are particularly helpful because they report full year data for the previous year, broken down into individual industry and sub-sector. The median revenue of businesses in the dataset is just over $500,000, so it is truly focused on small businesses. And with over 2,500 sales per quarter included in the reports, they represent a large sample.
BizBuySell does not report its methodology in any detail, so it is difficult to use the data to discern trends over time, and all of the findings need to be taken with some caution. The brokers who voluntarily provide the data have a vested interest in its outcome (showing higher sales prices and less time on the market, for example). And BizBuySell itself has an interest in encouraging more people to sell their businesses, so the commentary has an uncannily consistent positivity, always indicating that “now” is a great time to sell your business.
But the findings are useful, both on a global and an industry-specific level. Methodological concerns aside, it is extremely rare to find such a detailed dataset focused on small business sales.
IBBA MARKET PULSE REPORTS
The International Business Brokers Association (IBBA) also publishes quarterly reports based on surveys of business brokers – its “Market Pulse” reports. Much smaller in size than the BizBuySell datasets, these ones typically include 250-300 sales per quarter. And they vary in size from very small businesses up to mid-market companies (the largest category of which is $5-50m enterprise value). The data is broken down by company size though, so we can easily see which data points are relevant to smaller businesses and which aren’t. And we can also use the data to understand how company size affects the outcome in each case.
WHAT DOES THE DATA TELL US
Full analyses of the latest reports from both sources are in the video. They include insights into:
PE Multiples by Industry
PE Multiples by Size
Time on Market
Deal Structures
And More
The most interesting insights are the earnings multiples. The BizBuySell report has a full breakdown for last year by industry sector, which is fascinating (we have transferred this data into a spreadsheet also – just email us if you would like a copy). It covers not only earnings multiples (of both revenue and SDE), but the number of sales, median sales prices, median asking prices, revenues and SDE.
Earnings multiples as a function of company size are illustrated best by the IBBA reports. Their tables break down the data into their five categories of business size, enabling comparison between them:
The data showed that, in the most recent quarter, the median multiple for a business valued at less than $500k was 2.0 x the Seller’s Discretionary Earnings (SDE). This multiple increased to 2.3 x for businesses between $500k and $1M in value, and to 3.3 x for businesses that sold for between $1M and $2M. Multiples for larger businesses are shown as a multiple of their EBITDA, as you can see in the table.
Helpfully, the IBBA also provides these multiples in the form of a range, showing where the bulk of the valuations were placed for businesses in each category. The $2-5m category is reported as a multiple of both SDE and EBITDA, so that we can see both the multiples themselves and we can also observe how the choice of earnings metric affects the retrospectively-calculated multiple for the same businesses.
CHALLENGES
Besides the methodological issues associated with the data collection and reporting, there is one very important point to remember about comparable sales data: they include only sold businesses. Remember that within the realm of small business, most do not sell. This means that the ones that did sell were among the best-in-class in the factors that increase "saleability" - characteristics like systematisation, stability and reliability. When using comparable data it is critical to remember that those businesses that sold, and were therefore included in the data, had higher scores in these metrics than the average business. Sold small businesses are not average small businesses.
In addition to these issues, people outside of the US have to contend a couple of other problems. While some of the multiples are reported as multiples of EBITDA, the key earnings multiples for small businesses use Seller’s Discretionary Earnings, a term that is not widely used outside of North America. In order to use the comparable data, the SDE (or a similar adjusted net profit) must first be calculated for the target company.
In addition to this, there is the concern that data from one country will not directly apply to another. To look into this, we compared the PE multiples from the IBBA data and from a UK study of PE multiples of private companies by the consulting firm Menzies. By comparing the most similar size brackets to each other (both conveniently presented as a multiple of EBITDA) we can compare the PE multiples, and the comparison shows that both datasets produced multiples in the same range.
As discussed in the video, this finding alone does not mean that all of the US data will be directly applicable to the UK or any other country. But it suggests that at least the multiples will be within a reasonable range, and the data should not be widely different. Each industry will vary in how similar it is to the United States, and this will affect how closely the industry-specific multiples apply in a different country.
But given how little data there is on small business sales in most countries, the IBBA and BizBuySell datasets provide much-needed comparable data. As long as the problems and potential biases in the data is understood, these sources can add meaningfully to the process of valuing a small business. Combined with local industry knowledge, and the core valuation principles, they can be very useful.